A tax on financial transactions will reign in banks and other financial institutions, and may prevent another crisis.

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"Financial institutions should not get rich at the expense of the rest of us," writes Baker [AFP]

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As we mark the fifth anniversary of the Wall Street bailouts, it is clear that little has changed in the way they do business. They are still engaging in the same sorts of market manipulation and tax gaming as they did before the crisis.

The weak conditions on the bailout money had no lasting effect in areas like executive compensation. The industry itself is more concentrated than ever as the big banks used the crisis to merge with other banks, making them even bigger. And theDodd-Frank reforms have been watered down to the extent that many are now pointless.

It's clear that Wall Street won that round. Their greed and incompetence would have put most, if not all, of the big Wall Street players out of business in the 2008 crisis. Thanks to their power with top figures in both political parties, they were able to count on government hand-outs to get out of the mess they had themselves created. And, thanks to Wall Street's ability to influence reporting on financial issues, most people reading about the anniversary of the bailouts will be told that we are lucky things turned out as they did. After all, we didn't get a Second Great Depression.

Time for a new idea

Avoiding a Second Great Depression, like avoiding the Black Plague, is not much grounds for celebration. We usually don't expect either. No one should be thanking anyone connected with Wall Street for avoiding a horrible event that never even should have been a possibility.

This brings us back to the problem of dealing with an out-of-control financial sector. The efforts to do finely-focused fixes in Dodd-Frank largely went nowhere. This calls for a different approach: regulating the industry with a sledge hammer known as a financial speculation tax.

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The idea is simple and old. We can place a small tax on financial transactions to discourage rapid turnover. Eleven countries in the European Union are planning to impose a tax of 0.1 percent on stock trades and 0.01 percent on most derivative transactions. Senator Tom Harkin and Representative Peter DeFazio have proposed a tax of 0.03 percent on both types of transactions. Representative Keith Ellison has proposed a somewhat higher tax.

Such taxes can raise large amounts of revenue, which would come almost exclusively out of the hides of the Wall Street gang. The Joint Tax Committee of Congress estimated that the Harkin-DeFazio tax would raise close to $40bn a year.

While much of the tax itself would be largely passed on in higher transactions costs, there is considerable research showing that investors and other end users respond to higher trading costs by cutting their transactions in roughly equal proportions. In other words, the research shows that if it costs twice as much to trade a share of stock, most investors will engage in roughly half as much trading. In that case, the amount that investors spend on trading each year will be little changed, even if they pay more per trade.

The same story applies to other end-users in financial markets. For examples, farmers are likely to buy and sell somewhat fewer futures contracts on their crops. And airlines will buy and sell fewer options on jet fuel.

The trades themselves end up a wash since every trade that has a winner also has a loser. The real losers from the reduction in trading volume that would result from a financial transactions tax are the banks. They would both see fewer trades and likely be able to pocket less money on each trade as a result of the tax. This is really a horror story for them.

Banks fight back

This is why they are pumping out nonsense at record paces, arguing that the world will end if we impose financial transactions taxes. They claim that investors will see enormous increases in costs, because somewhere they will decide to trade more than ever so that they can pay the tax hundreds of times a year. (Seriously, that is what these folks say and business reporters repeat.)

They claim that everyone will just move their trades to places like Hong Kong, China, India, and Singapore. They never mention that all these markets already have financial transactions taxes. In fact they somehow forget that the London stock exchange has been taxing stock trades at the rate of 0.5 percent. This tax dates back more than three centuries and raises the equivalent (relative to GDP) of $40bn a year in the US.

The financial industry guys even claim that trade agreements make the imposition of effective financial transactions taxes illegal. This is an interesting argument. Does anyone remember the politicians pointing out that their trade deals would make it impossible to tax financial transactions in the same way we tax shoes, cars, and nearly everything else we consume? Did the media report this at the time?

If trade deals actually do prohibit financial transaction taxes then that would be a great item to amend in current trade negotiations. And we should immediately fire lots of trade reporters and editors for being so ungodly incompetent that they neglected to mention this fact in their coverage of past trade deals.

But the reality is that there is no good reason not to tax the Wall Street folks who gave us this crisis. The only reason financial speculation taxes are not front and center on the national agenda is the power of the financial industry. Just as was the case five years ago, they are using this power to get ever richer at the expense of the rest of us.

Dr. Dean Baker is a macroeconomist and Co-Director of the Center for Economic and Policy Research in Washington, D.C. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University. (more...)